Can't afford a market fall

An equity crash will hurtle the world towards a much deeper recession than that in 2008-09.

In a world where economic recovery is still very fragile, policymakers simply cannot afford equity markets to crash. And, this is why 2011 is unlikely to be a repeat of 2008. The last time financial markets went into a tailspin, the world saw its worst recession since the Great Depression. Moreover, the problems of 2011 are not caused by profligate institutions. This time, the culprits are governments, who have failed to spur growth despite their loose monetary policies. While the jury is still out on the real impact of these policies, it’s the only thing that can save the world from another recession, economists say. So, those waiting for QE3, voila.

For instance, Nomura’s global team of economists has downgraded growth estimates for the US & euro zone, but not Asia, as it is waiting to see how policymakers and financial markets react over the next few weeks. Says Sonal Varma, Nomura’s India economist, “If the markets continue to act nervously, a lot will change. Policymakers have to create a firebreak.”

For instance, in the US, housing and equity markets are the biggest drivers of the wealth effect. With the former yet to recover from the 2008 crisis, a meltdown in the stock market would be disastrous for the Americans. Interestingly, after the downgrade, US treasuries fell to 2.33 per cent, reiterating their status of a safe haven. However, equity markets saw a bloodbath.

The US seems to be aware of the dangers stemming from the equity markets (a barometer of a country’s economic health), which is why the Federal Open Market Committee (FOMC), on Tuesday, decided to formally extend the “extended period” for an exceptionally low fund rate to mid-2013.

“The committee ‘anticipates’ economic conditions are likely to warrant exceptionally low levels for the fund rate ‘at least’ through mid-2013. This could prevent the situation from getting worse, or may actually help foster a faster rate of economic growth,” says Kevin Logan of HSBC Securities (USA).

In response to FOMC’s move, the Dow Jones industrial average rallied 429.92 points (four per cent) on Tuesday to 11,239.77, the biggest percentage gain since the bull market began in March 2009.

On its part, the European Central Bank bought Italian and Spanish bonds for the second day on Tuesday, according to reports. Spain’s 10-year yield fell eight basis points to 5.08 per cent on Tuesday, extending Monday’s slide. The extra yield demanded by investors to hold Italian 10-year securities instead of benchmark German bunds dropped 21 bps to 281 bps on Monday, the least since July 22.

Not surprisingly, India’s benchmark indices – Sensex and Nifty – closed in the green on Wednesday. But, if this latest round of stimulus fails to revive growth, the world’s biggest economy could be headed for another recession.